Clearing process

What you will learn

  • What the authorization process is
  • What the clearing process is
  • What the settlement process is

What you should read first

Full article

This is part 2 of 3 of the authorization and settlement article. Here are links to each part:

Introduction

In the previous part, we discussed the mechanics of the authorization process. Recall that this occurs while a customer is in the middle of a transaction and involves a card association and issuing bank performing checks such as whether the cardholder has sufficient funds and whether the card being used is fraudulent.

This part covers the clearing process and will elucidate how the card associations and processors calculate the funds that must be transferred between banks on behalf of their merchants and cardholders for their transactions.

Clearing process

Capturing and batch processing

When a merchant performs a transaction and the customer leaves the store, the merchant has not yet received payment for that cardholder's purchase yet. The next step is for that merchant to create a record of that authorized transaction to enable that payment later.

The process of creating that record is called electronic draft capture (or sometimes just draft capture or capture or electronic ticket capture) and the records themselves are called electronic drafts.

Electronic draft capture
The process of storing information about an authorized transaction in a record called an electronic draft. These electronic drafts are then used to later send payment to merchants for the purchases they have completed with cardholders.

As a merchant conducts transactions during the day, they accumulate electronic drafts in a group called a batch. Then, often at the end of the day, although this frequency can vary for merchants with very high or low amounts of transactions, the merchant sends this batch of electronic drafts to their processor, a process called batch processing.

Batch
The group of electronic drafts that a merchant has accumulated over a recent period (typically the past day).
Batch processing
The process of a merchant submitting their current batch of authorized transactions to their processor.

Clearing

There are actually two types of processors. The type of processor we've discussed so far — the processor that a merchant sends their transactions and batches to — is called a front-end processor.

Front-end processor
The processor that a merchant communicates with. This is the processor that receives transactions from a merchant and performs authorization as well as the processor that receives batches from a merchant.

When a front-end processor receives batches from merchants, it organizes those batches into groups by acquiring bank. Banks are identified by a number called a Bank Identification Number, and it is this number that is used to group batches.

Bank Identification Number (BIN)
The number that identifies a bank.

The front-end processor then simply sends these groups of batches onto the second type of processor: the back-end processor. The back-end processor performs several functions:

  • Check for rejected transactions. For example a transaction with an unknown account number
  • Perform risk management procedures
  • Format the daily records for merchant statements [1]

After performing the above functions, the back-end processor then sends the electronic drafts to the appropriate card association, so Visa transactions for example, are sent to Visa.

The card associations then organize the drafts into groups, with one group per issuing bank.

What you should read next

References

  1. "Introduction to Electronic Processing," Electronic Transaction Association University